Using Letters Of Credit For Tenant Credit Enhancement


I. Introduction.

Cash security deposits (typically in the amount of one or two month’s rent) have been the traditional form of tenant credit enhancement required by commercial landlords. However, in instances where landlords feel more at risk (such as in today’s uncertain economic times), landlords often seek to receive more than a cash security deposit. A letter of credit is a common alternative or additional enhancement, and in some instances, may be favored over a cash security deposit. A letter of credit is an instrument in which an issuing bank, at a customer’s (tenant’s) request, agrees to honor a draft or other demand for payment made by a third party (landlord) as long as the demand complies with specified conditions. In essence, the bank’s creditworthiness is substituted for that of its customer and the credit risk is shifted to the issuing bank.

II. Credit Enhancement for a Commercial Lease.

A. Standby Letters of Credit - An irrevocable, standby letter of credit is the standard form that this instrument takes in the context of security for a commercial lease. Unlike the commercial letter of credit, the standby letter of credit functions as an assurance of payment rather than a source of payment and is meant to be drawn upon only if a default occurs.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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